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Fragility of reputation and clustering of risk-taking

  • Guillermo L. Ordoñez

Concerns about constructing and maintaining good reputations are known to reduce borrowers' excessive risk-taking. However, I find that the self-discipline induced by these concerns is fragile, and can break down without obvious changes in economic fundamentals. Furthermore, in the aggregate, breakdowns are clustered among borrowers with intermediate and good reputations, which can exacerbate an economy's weakness and contribute to a broad economic crisis. These results come from an aggregate dynamic global game analysis of reputation formation in credit markets. The selection of a unique equilibrium is accomplished by assuming that borrowers have incomplete information about economic fundamentals.

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Paper provided by Federal Reserve Bank of Minneapolis in its series Staff Report with number 431.

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Date of creation: 2009
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Handle: RePEc:fip:fedmsr:431
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